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Providing Sec. 132 Fringe Benefits to S Corporation Employees

S corporations can offer employees the same
fringe benefits as other business entities; however,
so-called 2% shareholders (shareholders owning more
than 2% of the corporation’s outstanding stock on
any day during the S corporation’s tax year,
considering both direct and constructive ownership)
are treated as partners for fringe benefit purposes.
Because partners generally are considered
self-employed persons rather than employees,
tax-favored treatment (i.e., corporate deductibility
and employee exclusion from income) for employee
fringe benefits paid on behalf of 2% shareholders
appears to be unavailable unless a specific statute
treats a partner as an employee.

No-Additional-Cost Services

No-additional-cost services are excluded from
income if the service is sold by the S corporation
in the line of business in which the employee
performs services and the S corporation does not
incur any significant additional costs (including
forgone revenue) in providing these services to the
employee (Sec. 132(b); Regs. Sec. 1.132-2(a)). The
nondiscrimination rules of Regs. Sec. 1.132-8 apply,
and only excess capacity services (such as hotels;
transportation by aircraft, train, bus, subway, or
cruise line; or telephone services) qualify for the
exclusion. Nonexcess capacity services (e.g.,
facilitating stock purchases by a brokerage house,
providing legal services to law firm employees, or
leasing property) are not eligible for the exclusion
but may be eligible for the qualified employee
discount exclusion.

Qualified Employee
Discounts

A qualified employee discount under
Sec. 132(c) is a price reduction provided to an
employee on property or services generally offered
to outside customers in the S corporation’s ordinary
course of business. A common example is an employee
discount for retail store employees. The employee
must perform services in that line of business to
qualify for the income exclusion under Regs. Sec.
1.132-3(a), and the nondiscrimination rules found in
Regs. Sec. 1.132-8 apply. Employees cannot exclude
discounts on real and investment-type property from
income.

For qualified property, the discount
cannot exceed the gross profit percentage at which
the employer offers the property to customers. For
services, the discount cannot exceed 20% of the
price at which the employer offers the services to
customers. Any discount over these limits is a
taxable fringe benefit (Regs. Sec. 1.132-3(e)).

Working Condition Fringe Benefits

A
working condition fringe benefit includes property
or services provided to an employee that the
employee could deduct as a trade or business expense
(or as a depreciable asset) if the employee had to
pay for it (Sec. 132(d); Regs. Sec. 1.132-5(a)(1)).
Examples include on-the-job training, professional
dues, business-related magazine subscriptions,
certain outplacement services, business use of a
company car, and business travel and entertainment.
Nondiscrimination rules do not apply.

If the
employee uses the property or service directly in
the employer’s business, such as the use of an
employer-provided auto on a business trip or for
local transportation between branches or plant
locations, a clear business connection exists. If
the employee does not use the property or service or
uses it only indirectly in the employer’s trade or
business, the proper approach is to determine if,
under the facts and circumstances, the employer
derives a substantial business benefit from the
property or services that is distinct from the
benefit it would derive from paying compensation
(Regs. Sec. 1.132-5(a)(2), Examples (3) and
(4)).

Many employers have programs to assist
current (and sometimes terminated) employees in
finding other employment. The assistance can be
in-house or through an outside firm and can include
counseling and testing as well as help with résumé
writing, job search strategy, and interview
training. For employer-provided outplacement
services to be considered a working condition fringe
benefit, the employer must derive a substantial
business benefit. Examples can include promoting a
positive corporate image, maintaining employee
morale, and reducing the likelihood of wrongful
termination suits.

De Minimis Fringe Benefits

De minimis fringe benefits include property or services
provided to employees that have such a small value
that accounting for them would be impractical
(Sec. 132(e); Regs. Sec. 1.132-6(a)). Included in
this category are occasional employee parties or
picnics; coffee and doughnuts; occasional use of
the copy machine; typing of personal letters by
the company secretary; and local telephone
calls.

In general, the nondiscrimination rules do not
apply to de minimis fringe benefits. Thus, a de minimis fringe benefit may be excludable even if it
is provided to highly compensated or key
employees.

The following are not excludable as de minimis fringe benefits (Regs. Sec.
1.132-6(e)(2)):

Season tickets
to sporting or theatrical events;

The commuting use of an S corporation–provided
vehicle more than one day per month;

Membership in a private country club or
athletic facility; and

Use of
corporate owned or leased facilities (such as a
hunting lodge or boat) for a weekend.

Job-Related Education

Employer payments
or reimbursements for job-related educational
expenses also can be excluded from the employee’s
income as a working condition fringe benefit.
Job-related qualifying education is education that
(1) is required by an employer or the law to keep a
present salary, status, or job; or (2) maintains or
improves skills required for present work (Regs.
Sec. 1.162-5). However, education expenses will not
qualify for the exclusion if the education is needed
to meet the minimum job requirements or qualifies
the employee for a new trade or business. A change
of duties is not a new trade or business if they
involve the same kind of general work. Nor is a
change from one employer to another.

The
minimum educational requirements for a job are
determined by statutes and regulations, professional
or business standards, and the employer. An employee
has not necessarily met the minimum requirements
simply because he is already doing the work (e.g.,
an accountant working in a CPA firm who has not
obtained his CPA certificate has not met the minimum
requirement until he obtains his certificate). Once
an employee has completed the education or
experience required for a professional license, the
expenses necessary to maintain a license or status
(including dues) are ordinary and necessary
expenses. If the minimum requirements change (for
example, the employer or the law requires more
education) or if recertification or redesignation
must occur, any additional education needed to meet
the new or continuing requirements is qualifying
education.

Educational expenses qualifying for
working condition fringe benefit treatment include
tuition, books, supplies, tools, lab fees, seminar
registration fees, and similar items. Some
transportation expenses qualify, such as the cost of
going directly from work to school (but not from
home to school) and, for temporary or short-term
classes or seminars, the cost of the entire round
trip. Other qualifying expenses include
correspondence courses, tutoring, and formal
training.

Employees can incur job-related educational
costs for virtually any type of education,
including formal university training; professional
development or enrichment seminars sponsored by
professional societies or trade organizations; and
in-house training. Education during a vacation,
temporary leave, or other temporary absence also
can be related to the employee’s present job. If
the employee stops work for a year or less and
then returns to the same kind of work, the absence
is temporary (IRS Publication 970, Tax Benefits for Education, p. 66 (2011)).

Club Dues

No deduction is allowed for dues paid for
membership in any club organized for business,
pleasure, recreation, or other social purposes (Sec.
274(a)(3)). The purposes and activities of a club,
and not its name, are the determining factors. Clubs
in this category include country clubs, golf and
athletic clubs, health clubs, airline clubs, hotel
clubs, and clubs operated to provide meals under
circumstances generally conducive to business
discussions. Unless the facts show otherwise, the
following are not within this category: business
leagues, trade associations, chambers of commerce,
boards of trade, real estate boards, professional
organizations (such as bar and medical
associations), and civic or public service
organizations (such as Kiwanis, Lions, Rotary, and
similar organizations) (Regs. Sec.
1.274-2(a)(2)(iii)). Accordingly, dues paid to such
organizations are deductible.

Nondeductible
commercial athletic or country club dues may qualify
as a working condition fringe benefit (i.e., can be
excluded from the employee’s income) if the employee
substantiates a business connection. A business
connection exists if the employee uses the club
primarily to further the S corporation’s business.
Also, to qualify as a working condition fringe
benefit, the S corporation cannot deduct the dues as
compensation (Regs. Sec. 1.132-5(s)).

Cellphones

If there are substantial
noncompensatory business reasons for an employer to
provide an employee with a cellphone, the employee’s
business use of the phone is a tax-free working
condition fringe benefit (Notice 2011-72). Examples
of noncompensatory business reasons include an
employer’s need to contact the employee at all times
for work-related emergencies, the employer’s
requirement that the employee be available to speak
with clients when the employee is away from the
office, and the employee’s need to speak with
clients located in other time zones at times outside
the employee’s normal work day. If the employer
provides a cellphone for compensatory reasons (e.g.,
to promote employee morale), only the business use
qualifies as a tax-free working condition fringe
benefit.

Rules similar to those in Notice
2011-72 apply to employer reimbursements to
employees for the business use of the employee’s
personal cellphone (SBSE-04-0911-083). Employers
that require employees, primarily for
noncompensatory business reasons, to use their
personal cellphones for business purposes may treat
reimbursements of the employee’s expenses for
reasonable cellphone coverage as nontaxable. This
treatment does not apply to reimbursements of
unusual or excessive expenses or reimbursements that
replace a portion of the employee’s regular
wages.

The winner of The Tax Adviser’s 2014 Best Article Award is James M. Greenwell, CPA, MST, a senior tax specialist–partnerships with Phillips 66 in Bartlesville, Okla., for his article, “Partnership Capital Account Revaluations: An In-Depth Look at Sec. 704(c) Allocations.”

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